Bangkok--16 Apr--Moody's Investors Service
Islamic banking in East Asia is slowly developing but needs more action by regulators to establish legal and regulatory frameworks if it is to emerge as a significant segment across the region, says a new report published by Moody's Investors Service.
The report notes that aside from Malaysia, where the industry's assets now account for 15.4% (about USD62 billion) of the country's banking system assets, its market penetration across the region has been somewhat patchy. For instance, while Islamic banking has achieved relatively high market penetration in Brunei and asset growth in Indonesia has been rapid (though off a low base), Islamic banking services available in the Philippines, Singapore and Thailand and remain very small in terms of asset size.
"There exists a natural business potential for Islamic banking services in Malaysia as approximately 60% of its population is Muslim, but it is government reforms during the past twenty to thirty years which have really helped develop the necessary legal and regulatory framework and institutions for the industry to flourish," says Christine Kuo, a Moody's analyst and author of the report. "The adoption of various incentives, including tax breaks, has also proven critical to nourishing the business.
"We believe the Malaysian experience over the last three decades demonstrates how instrumental regulators can and need to be in order to grow the Islamic banking sector," adds Kuo.
This compares to Indonesia, where the industry's market share is still less than 2% (about USD3 billion) despite rapid growth in recent years.
The low penetration in Moody's opinion, can largely be attributed to the slow pace of change to related regulations and institutions - though a few important changes seem to be gathering momentum, says the report.
"Indonesia has huge long-term potential as it is home to more than 200 million Muslims, the largest Muslim population in the world," notes Kuo, adding, "The growing acceptance of Islamic banking even among non-Muslims, combined with announcements from Singapore, Tokyo and Hong Kong that they are to increase their participation in Islamic finance, have also underlined the industry's potential."
However, as Islamic banks expand they will need to deal with the twin challenges of managing their rapid growth while competing against conventional banks. The former includes addressing risk issues specific to Islamic financial institutions, such as concentration risk due to a limited scope of eligible asset classes, higher costs for managing liquidity and concentration of liabilities. These can best be dealt with if the banks are not under undue pressure to grow assets too quickly.
"We think that the average bank financial strength ratings (BFSRs) of Islamic banks in East Asia are likely to be lower than their conventional banking peers in the same country because of higher Shariah Law-related compliance costs and lack of economies of scale. Nonetheless, deposit and debt ratings of Islamic banks could be significantly higher than the levels indicated by their BFSRs, thanks to support from parents and regulators," says Kuo.
The report, entitled, "Islamic Banking in East Asia -- Growing but not without Challenges", can be found at www.moodys.com.